Banking and
Capital Flows and
Capital Markets and
Finance and
Global Economy and
Public Policy and
Systemic Risk

Keith Savard is a fellow at the Milken Institute. He has extensive executive management experience with expertise in evaluating the interrelationship between economic fundamentals and activity in global financial and commodity markets. He also has a background in sovereign risk analysis and applying a disciplined economic approach to investment-portfolio decision-making.

The Federal Reserve has done its best since the global financial crisis to explain clearly its actions in undertaking exceptional monetary measures and to guide the public and market participants in what to expect next. This is meant to avoid confusion, which could potentially trigger adverse and unnecessary market reactions. During the time that the Federal Reserve was engaged in quantitative easing (QE), this approach generally worked well with the possible exception of the “taper tantrum.” However, as the central bank now moves to normalize monetary policy, and begins the process of raising policy interest rates, the notion of transparency as practiced by Fed governors and regional reserve bank presidents seems to be causing consternation among market participants.

In explaining its policy formulation process, the Federal Reserve has emphasized that it is highly dependent on domestic data. Great efforts have been made to discuss the assumptions behind Fed macroeconomic forecasts and to provide the public with insight via the now famous “dot-plot”[1] as to the thinking of Fed officials when it comes to the future path of policy interest rates. Unfortunately, like economists in the private sector as well as investors, the interpretation of data by those on the Federal Open Market Committee (FOMC) is not always uniform, resulting at times in mixed signals being sent by officials about policy. Such ambiguity is further compounded by the finely nuanced statements released after each FOMC meeting, which at times leads to more parsing of words rather than a more deep understanding.

Possibly the biggest flaw in this approach is that while the Federal Reserve is trying to steer expectations in the marketplace, investors—as they usually do—are trying to anticipate the likely movement of asset prices and act accordingly. However, following the last FOMC meeting a monkey wrench was thrown into the process when it was revealed that FOMC members were now worried about the situation in emerging markets and China in particular. This left both analysts and market participants wondering how they were to interpret the things that Fed officials were now examining. Was the Fed now becoming market dependent as well as data dependent? Or perhaps more starkly, was the FOMC just looking for an excuse not to raise interest rates in the belief that such action could trigger the bursting of an asset price bubble, resulting from an excessive use of exceptional monetary measures?

Whatever the reason for the FOMC’s behavior, analysts and pundits alike have attacked with vitriol. This is somewhat unusual, as the Federal Reserve has generally been treated by the media and analysts with a great deal of respect, if not deference. Looking at a sampling below of headlines from recent articles in financial newspapers and blogs gives an indication of how the situation has changed:

Fed Must Stop Dithering and Take Action – Financial Times

What to Make of Contradictory Fed Babble – David Stockman’s Contra Corner

The Fed’s Alice in Wonderland Economy, What Happens Next? – Casey Research

We Still Aren’t Sure What Will Cause Janet Yellen to Pull the Trigger – Bloomberg Business

Yellen Flinches – First Trust Advisors

You Can Actually See the Desperation – Alhambra Investment Partners

Markets Flummoxed by Uncertain Federal Reserve – Wall Street Journal

Senior Federal Reserve officials, including Janet Yellen, have responded by making a concerted effort to explain the intricacies of the decision not to raise the federal funds rate in September as well as to offer reassurance that the central bank is using every tool at its disposal to arrive at a solid decision regarding the need for policy change. Indeed, last week, Chairperson Yellen, playing to her strength as a highly respected academic, presented a 40-page paper with 35 footnotes and nine charts to an audience at the University of Massachusetts, Amherst. The paper covered in excruciating detail inflation dynamics and monetary policy. The audience was riveted. However, this was because Yellen appeared frozen and confused near the end of her talk. It was later learned that she suffered from dehydration and fatigue after a long day of travel and other obligations.

With U.S. and other financial markets having recently experienced a correction for the first time in several years along with increased volatility, investors, policy makers and the general public seem to be growing increasingly concerned about the state of the global economy and whether another bout of financial systemic risk might be around the corner. Given the level and type of uncertainty that now exists, a case can be made for central banks to be more low-key, if not silent, in the lead up to their decision making. For most of their existence central banks acted this way. However, in an age of instant communication and social media, a stigma of doubt and suspicion often arises when a public institution is deemed less than forthcoming.

Otto von Bismarck—known as the “Iron Chancellor” of Germany—once said, “Laws are like sausages, it is better not to see them being made.” The same might be said about monetary policy. While debating the decisions of the FOMC is fair game, the prelude to decisions is another matter, as it can be argued that much of the internal debate is tentative and akin to putting the pieces of a complex puzzle together. Add to this the communications issue mentioned above and you have a recipe for a potentially unpleasant outcome. Former Fed Chairman Alan Greenspan may have said it best when he opined, “I guess I should warn you, if I turn out to be particularly clear, you’ve probably misunderstood what I said.”

[1] Federal Reserve officials publish their forecasts for the central bank’s key interest rate on a chart known as the “dot plot.”